Next worry for stocks: Earnings slowdown

Subprime mortgage woes have stolen the spotlight of late but very soon slow earnings growth will be back in focus.

By Alexandra Twin, CNNMoney.com senior writer

March 16 2007: 12:17 PM EDT

NEW YORK (CNNMoney.com) -- With "subprime" on everyone's lips and recession questions back in vogue, the stock rally's other big antagonist has been enjoying a low profile of late.

But not for much longer. With the first quarter winding down and the corporate confessional period heating up, Slow Earnings Growth is set to stage a comeback. And it ain't gonna be pretty.

Market professionals have been calling for a pronounced slowdown in earnings growth for so many quarters - without it really happening - that it's not hard to mistake them for a pack of boys who cry wolf.

The fourth quarter of 2006 was the 14th straight with S&P 500 earnings growing at least 10 percent from a year earlier. But that's where the trend falters.

Earnings in the first quarter of 2007 are currently set to grow about 4.3 percent from a year ago, according to current Thomson Financial estimates. Second-quarter earnings are on track to grow 4.4 percent, while third-quarter earnings look to grow 6.6 percent.

Overall reported earnings typically beat estimates by about 3 percent, so final results will likely be higher than these forecasts. But that doesn't change the bigger picture - that earnings growth for most of 2007 will be the slowest in years.

For all of 2007, earnings are expected to grow just 6.6 percent, which would make 2007 the slowest year for growth since 2002, when S&P earnings were pretty much flat - and the S&P 500 index slumped more than 23 percent, in the third year of the bear market.

Earnings growth was already set to wane for real this year due to slower global economic growth, tougher comparisons after several strong years and because of a slowdown in the recent earnings driver - the energy sector.

Now add in the worries about the financial sector, and you have another reason that earnings won't be able to keep up the pace.

A number of widely held companies have already issued dour forecasts for the current quarter and many analysts have cut their forecasts on stocks, particularly in the energy sector, said John Butters, Thomson Financial's senior analyst.

As a result, the forecasts for overall first-quarter earnings growth and for 9 of the 10 individual S&P sectors that Thomson tracks have all been downwardly revised.

Interestingly, in light of the worries about subprime, financial is the one sector that has seen growth forecasts revised upward, largely due to Goldman Sachs, which reported a blowout quarter earlier this week and had encouraging comments to make about the rest of the year.

However, Butters said that downward revisions to financial sector estimates could be forthcoming.

A few retailers have already reported quarterly earnings, with less than stellar results. Costco (Charts), the wholesaler, reported weaker fiscal second-quarter profit earlier this month and warned about the current quarter.

In the past few weeks, many subprime mortgage lenders - companies that lend to people with weak credit - have seen a spike in defaults on loans.

This has battered the stocks of firms such as Accredited Home Lenders (Charts), and raised worries about how the broader financial sector will be impacted.

It has also sparked debate about how the already troubled housing market and broader economy will be affected. Ex-Fed Chairman Alan Greenspan made comments on Thursday suggesting the subprime problem could spread, although he said much of that would go away if home prices started rising.

Yet, reassuring comments from some of the major investment banks this week have tempered worries about the "contagion" effect of subprime, at least so far as earnings are concerned.

Home improvement retailer Lowe's (Charts) has said that mortgage woes could hurt earnings and some analysts think other retailers could be hurt by any hit to the consumer's ability to spend. But the impact is not expected to be substantial. (Full Story).

General Motors (Charts), which finally released its delayed fourth-quarter results earlier this week, also mentioned the impact from subprime. Yet, GM's issues go deeper, with the company warning of broad accounting problems Thursday.

The companies set to take the biggest hit from the fallout are of course, the subprime lenders, such as Accredited Home, NovaStar Financial (Charts), and New Century Financial, the poster child for subprime malaise.

While Accredited and the other niche lenders are not S&P 500 companies, the broader issue of slower earnings growth is primed to stage a comeback in the weeks ahead.